3.8 WACC Practice Problem
You are given the following problem. What is the firm’s WACC?
LCM Corp.
As of 12.31.20XX
(000)
| Long-Term Debt (LTD) | $250,000 | Corporate Tax Bracket | 21% |
| Preferred Stock | 50,000 | Interest Rate in Debt | 5% |
| Common Stock @ Par | 300,000 | Cost of Preferred Stock | 7% |
| Additional Paid-in-Capital | 10,000 | Cost of Retained Earnings | 10% |
| Retained Earnings | 500,000 | Cost of Common Stock | 12% |
| Total Equity + LTD | $1,110,000 | ||
Solution: Here is the formulation – do you agree? YOU do the calculation!
WACC = (250/1,110) (.05) (1-.21) + (50/1,110) (.07) + (500/1,110) (.10) + (310/1,110) (.12)
= ???
Question: What happens to the WACC if the firm raises more debt capital to fuel growth? Assume ceteris paribus.
(The answer to the problem above is: WACC = 0.0906. Don’t tell anybody!)
